Compound Interest: A Saver's Best Friend

Growing up is tough enough without the worries of your financial future, so Money101 is here for you. E-mail your questions to Money101@FOXBusiness.com, and let us take off some of the pressure.

Dear Money101:

I am currently making $22,000 a year and am a little strapped for savings. Should I wait to save money later on when I will (hopefully) make more money? -Sam

It takes a lot of discipline to put a portion of your paycheck into savingsâ€”especially when money is tight, but even socking away just a small amount from an early age can really add up in the future.

â€śPaying yourself first by saving a portion of your income before it gets put into your spending account is a wise way to save money,â€ť says Erin Constantine, a spokesperson for Wells Fargo Consumer and Small Business Deposits. â€śEven if current interest rates on savings accounts are low by historical standards right now, young people can still build up a balance by making regular deposits.â€ť

Life is full uncertainties, and having money set aside to act as cushion to help pay for them will keep you out of debt. â€śIf you start saving early with smaller amounts of money, you are guaranteeing yourself some savings later in life. Plus, you get the bonus of compounding interest,â€ť says Reyna Gobel, author of Graduation Debt: How to Manage Student Loans and Live Your Life.

Compound interest is a savers best friend--by earning interest on your interest. Compound interest is a fixed rate of "rent" on the amount of money you place in an account that pays a guaranteed interest rate. The annual percentage yield [APY], which takes into account the effect of compounding, is what you will actually receive in a year. Knowing the APY allows you to compare different bankâ€™s rates.

â€śWhen you earn simple interest, you only earn interest on the amount you save or invest, no matter how long your money sits there,â€ť explains Gobel. â€śWith compounding interest your interest also earns interest. So letâ€™s say you save $100 per month for 20 years with a 3% interest rate.

Your total investment is $24,000. You earn an extra $7000 in 20 years of simple interest.

However, if your interest compounded monthly, you would earn about $9,000 in interest with the same monthly deposit.â€ť

If you can secure an interest rate that compounds more frequently, such as quarterly or monthly, the more interest youâ€™re going to accrue.

However, with banks taking a hit in the last two years, many of them have slashed their interest rates. But itâ€™s good to get into a savings routine now and get accustomed to saving and build up a stash that can really blossom when rates start to climb again.

â€śThere are a variety of ways to create a savings habit â€“ you can make it automaticâ€¦or make it a point to save a set percentage of income, which could be allowance, birthday money, or from a part-time job,â€ť says Constantine.